Packaged Food: Past Its Sell-By Date?

By Sam Stovall An industry that has exhibited an erosion in its rolling 12-month relative-strength ranking is the S&P 1500 Packaged Foods & Meats group. This index consists of 25 large-, mid-, and small-cap companies. Year-to-date through Nov. 11, this subindustry index declined 6.3%, while the overall market rose 2.6%. During 2004, this subindustry index outperformed the broader market, rising 15.5%, while the S&P 1500 advanced 10%.

That performance is evident in the subindex's 12-month relative-strength price chart (pictured below). As a reminder, the jagged blue line represents the subindustry index's rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the sub-industry index's 15-year mean relative strength.

SATED APPETITE? This subindustry's operating earnings are expected to advance 9% in 2006, vs. an anticipated decline of 2% in 2005.

So why then is the relative price going in the opposite direction of its earnings expectations? To help answer this question, I checked the subindustry outlook found in S&P's Stock Reports & Monthly Industry Review to see what Richard Joy, packaged-foods analyst and consumer-staples sector group head, had to say.

Joy thinks that while the industry will benefit from interest in high-quality issues, he sees a lack of sales growth for packaged-food companies, as well as concerns about raw-material input and energy-cost pressures, pension costs, and private-label competition, leading to performance in line with the broader index.

FEW MERGER CANDIDATES. He believes cost pressures are a key concern for the industry, primarily from increased commodity, pension, and fuel costs. While many agricultural commodities are now below recent highs, energy and packaging costs remain above year-ago levels. However, he thinks industry profit margins are likely to improve, on cost savings accruing from aggressive restructuring actions undertaken by most major companies in recent years.

The impact of rising commodity prices should vary among companies, but Joy thinks heavy-grain and feed users will likely be hurt most by higher prices. A number of companies should benefit from lower interest rates, as well as favorable currency translations.

Joy notes that there have been several large mergers among publicly-traded packaged-food companies since the beginning of 2000, which he believes have eliminated most or all of the desirable takeover targets. While there's still potential to see acquisitions of smaller niche companies, he thinks the lack of large buyers left in the marketplace is leading investors' attention away from merger speculation and toward market-share gains, earnings growth, and dividend yields.

In addition, Joy believes that rising standards of living, increasing world-trade liberalization, and the adoption of progressive economic policies around the world will provide U.S. packaged-food companies with more opportunities for longer-term growth.

So there you have it. In S&P's view, the subindustry's price momentum looks increasingly unattractive, while lackluster sales-growth forecasts and a variety of cost pressures could keep the group from adopting a leadership role.

Source: Standard & Poor's

Industry Momentum List Update

For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of November 11, 2005.

Subindustry

Construction & Engineering

Construction Materials

Diversified Metals & Mining

Fertilizers & Agricultural Chemicals

Health Care Services

Managed Health Care

Oil & Gas Drilling

Oil & Gas Equipment & Services

Oil & Gas Exploration & Production

Oil & Gas Refining & Marketing

Specialized Finance

Water Utilities

Required Disclosures

In the U.S.

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.7% of issuers with buy recommendations, 60.3% with hold recommendations and 11.0% with sell recommendations.

In Europe

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.8% of issuers with buy recommendations, 44.8% with hold recommendations and 20.4% with sell recommendations.

In Asia

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 28.1% of issuers with buy recommendations, 51.1% with hold recommendations and 20.8% with sell recommendations.

Globally

As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 29.3% of issuers with buy recommendations, 57.7% with hold recommendations and 13.0% with sell recommendations.

5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.

Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.

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